Defined Contribution Plans

A defined contribution plan is a plan that provides a stated "defined" contribution to the plan each year. The contribution is usually expressed as a percentage of an employee's compensation for the year. For example, a plan promising a contribution of 5% of compensation would provide a contribution of $2,500 to an employee earning $50,000.

A defined contribution plan differs from a defined benefit plan in that the plan's promise to the employee is for a particular annual contribution rather than a particular level of benefit at retirement age. This is a critical distinction in terms of plan funding. Once the contribution is made to an employee's account in a defined contribution plan, the employer has fulfilled its promise, and there is no continuing obligation to contribute additional funds. In a defined benefit plan, however, the employer is ultimately responsible for assuring the adequacy of plan assets to provide the plan's promised benefits. Thus, if plan assets decline in value, the employer is required to contribute additional funds to the plan.

Defined contribution plans come in three distinct forms...